Don't have a 401(k)? State governments have a retirement plan for you

Luke Huffstutter, owner of Annastasia Salon in Portland, Ore., said a wry joke runs through the hair-salon business in the U.S.: “When was the last retirement party you attended?”

The answer is never. That’s because stylists tend to work for small businesses, most of which don’t offer retirement-savings plans. Thus, stylists don’t retire.

But failing to save for retirement isn’t funny, and even if Huffstutter’s team stays in his employ for decades, his salon workers, like all Americans, will need money when they stop working.

“We have a responsibility to prepare them for after-work,” he said. “That’s just my belief as an owner. That’s my responsibility.”

Huffstutter spent a decade looking for the right retirement plan, with little to show for it. His business is successful — the company expects to net more than $2 million in sales this year — but, like many small businesses, has never been profitable enough to sustain a 401(k) plan.

At the same time, he knew that offering anything less than ideal would come at a cost to employees, in the form of tacked-on fees that would inherently damage their future balances. He solicited bids from six administrative companies, but nothing worked out.

Then along came Oregon’s state-sponsored retirement program, OregonSaves.

To get 10 members of his company to start saving for retirement on their own took him 10 years, he said. With OregonSaves, 26 people were able to sign up in 10 minutes. In the past year and a half, those employees have saved more than $56,000 in total. Huffstutter, who had financial advisers visit the salon to speak with employees about financial planning, estimated that 95% of his 42 employees are now saving for retirement, either through OregonSaves or outside of the program. His goal: 100%.

It was his dream, Huffstutter said, “that everyone would be saving.”

10 states sign on

Ten states including Oregon, California and Illinois are stepping forward to answer the prayers of small-business owners such as Huffstutter, who want to offer their employees a retirement plan but can’t afford to get it off the ground on their own, or might not know where to look.

Half of the private-sector workforce — some 58 million full- and part-time workers, according to the Pension Rights Center — is not participating in a workplace-sponsored retirement plan, a deficit that, if it continues, could quash workers’ futures and health, and strain the U.S. economy.

In the U.S., no employer is legally required to offer a retirement plan. Employers, especially small businesses, that don’t offer retirement plans to their workers often complain that doing so is too complicated and expensive. At the same time, even some employees who do have access to a plan don’t invest if they’re not automatically enrolled.

Related video: This is how much you should have saved at every age (provided by NowThis News)

There are significantly fewer companies offering traditional pensions these days, opting instead for defined-contribution plans like the 401(k), which require employees to voluntarily save for their futures rather than, as under a pension plan, receiving from the company a predefined amount for the rest of their lives. Only 16% of Fortune 500 companies offered a pension to new hires in 2017, down from 59% in 1998, according to London-based insurance company Willis Towers Watson. Some companies, like aerospace company Boeing (BA) and apparel-tag maker Avery Dennison (AVY) have eliminated or frozen their pension plans.

In the past few years, 10 states — Maryland, Connecticut, New Jersey, New York, Washington state, Vermont and Massachusetts, in addition to Oregon, California and Illinois — have agreed to create a retirement program designed for the private sector, and nearly all other states are considering implementing one. One city, Seattle, is offering its own program to those without a workplace-savings plan.

State-based Roth IRAs

The state plans are Roth individual retirement accounts (Roth IRAs), but employees are able to automatically invest in them through payroll deductions, as they do with 401(k) plans. The contribution limits are lower: IRAs allow a maximum of $5,500 (or $6,500 for individuals 50 and older) a year, compared with 401(k) limits of $18,500 (or $24,500, respectively). Because the state plans are Roth accounts, they are funded with after-tax dollars, and therefore are withdrawn tax-free at retirement. Individual retirement accounts are typically used by workers who don’t have access to a 401(k).

Oregon’s version of the plan has become a model: In just over a year since its pilot began, OregonSaves has amassed more than $7.6 million in contributions in about 19,100 accounts. That figure jumps by about $200,000 every week, according to Tobias Read, Oregon’s state treasurer.

“It’s a good step forward to getting more people covered,” said Jamie Hopkins, the retirement-income program co-director at the American College of Financial Services in Bryn Mawr, Pa.

California is starting its pilot program in November, and contributions will begin with the first payroll cycle after Jan. 1, 2019. The statewide launch is slated for July 1. The state is even considering opening up the program to individuals who are self-employed or working in the so-called gig economy, said Katie Selenski, executive director of the program, called CalSavers. Illinois’ program, Secure Choice, began its pilot program in May.

Some members of the financial-services industry argue that states shouldn’t be providing those sorts of plans, and that they offer a weak alternative with limited investment choices as well as higher fees.

Still, workers have to start saving somehow, and if they aren’t taking the initiative to do it on their own, states have decided to act for them. Without any improvement, there could be disaster. Americans won’t be able to afford leaving their jobs, instead working well into old age with assorted ailments illnesses. The federal and state governments will suffer as well, financially and societally, as their budgets are drained to care for and support elderly individuals.

The crisis is deepening

The federal government finally has taken up the issue. President Trump signed an executive order at the end of August directing the Treasury and Labor departments to review current policies and consider regulations that would make it easier for small businesses to offer 401(k)-type plans. “We believe all Americans should be able to retire with the confidence, dignity and economic security that you want,” Trump said of the executive order.

Study after study shows Americans losing confidence in a prosperous retirement, and yet, despite this, many are still not preparing properly. Some workers have said they just can’t set aside money living paycheck to paycheck, while others can’t make sense of financial advice and become discouraged, thinking they’ll never be able to figure it out.

Some 46% of Americans anticipate they won’t be financially comfortable in retirement, a Gallup poll in May found. The number of people who feel that way has grown since Gallup first began tracking this sentiment in 2002 to 2004, when 36% of nonretirees didn’t expect that they’d live comfortably in retirement.

It gets worse. Not only do half of Americans feel unprepared; many truly are. One in three Americans has less than $5,000 saved for retirement, and one in five has no savings at all, a 2018 study by Milwaukee-based Northwestern Mutual found. A third of baby boomers, who now range in age from 54 to 72, had somewhere between zero and $25,000.

Millennials buried in debt

Millennials, those born between 1981 and 1996, according to the Pew Research Center, are already expressing skepticism about their capacity to exit the 9-to-5 world. A MarketWatch article about saving for retirement in your 30s went viral in May, after it infuriated thousands of 30-somethings who read a suggestion by Boston-based Fidelity Investments, the largest 401(k) plan provider, that they should have twice their annuall salary saved by the time they’re 35 years old.

Many took to Twitter to express frustration with that concept, arguing they were too busy balancing the costs of student-loan debt, high rents or mortgages, daily responsibilities, and helping their parents and children to even think about stashing money away for retirement.

Even if saving even a small amount of money is beneficial, some millennials said it simply wasn’t realistic. Americans have more than $1.5 trillion in student debt, much of it carried by the millennial generation.

Retirement has become a stressful subject even for the people who are most prepared. A Fidelity analysis of its quarterly data showed retirement-plan balances have grown — 6% for employer-sponsored accounts and 7% for IRAs — and loans taken from 401(k) plans have dropped to the lowest point in almost a decade. Still, a recent survey by Allianz Life Insurance of North America found about half of people between 45 and 65 years old who had about $400,000 saved for retirement still felt behind, more so than those who felt they were on track.

Employers are starting to offer more financial-education programs and personalized advice to workers in an attempt to help them meet their financial goals and save for the future. But even when a plan is offered, workers may not take part — either because they don’t think they need to yet or because they can’t afford to.

Why more states will offer plans

More than a third of all employees work for a company that doesn’t offer a 401(k) plan or pension, according to Pew Charitable Trusts. Yes, there are other options available — such as individual retirement accounts and standard savings or brokerage accounts — but they have shortcomings as compared with payroll-deduction-type plans.

For starters, workers themselves need to set them up, which many people do not take the time to do. Additionally, individual retirement accounts, although the plan of choice for states, are not as attractive as employer-sponsored retirement accounts because their limits are lower and they offer no employer match.

Auto-enrollment, wherein workers are automatically put into a retirement plan, is a powerful tool. The concept, which is supported by Nobel Prize-winning economist Richard Thaler, might have added almost $30 billion to retirement-account balances in the past few decades. Between 15 million and 16 million people have boosted their savings rates, four times as many as in 2011, because of auto-enrollment, according to Thaler and colleague Shlomo Benartzi’s research. Some companies and employees are automatically escalating contributions each year.

“One of the beauties of the automatic features is, if you take your natural inclination not to do anything, you’ve made a good decision [in not having opted out],” said David John, a senior strategic policy adviser at the AARP Public Policy Institute, which advocates on behalf of older Americans. “If we wait and say to people, ‘Well, here’s a brochure, you can read it or take an online course to learn the difference between a stock and a bond,’ a number of people will just ignore it.”

Perhaps the most frightening fact that must be considered is that a lack of retirement money poses a danger to the economy, said Angela Antonelli, executive director of the Georgetown Center for Retirement Initiatives in Washington, D.C. “Policy makers have to be concerned about what the implications will be of a population that will age and retire with insufficient retirement income,” she said.

That means more people will rely on safety-net programs, such as food stamps and housing assistance. The Pennsylvania Department of Aging is one of the smallest departments in the state but has an annual budget of nearly $800 million dedicated to preserving the quality of life for older residents. The department’s programs include home-delivered meals, caregiver support and job training. Another Pennsylvania analysis found that the Keystone State currently spends more than $4 billion on the elderly, and that figure is expected to swell by more than 50% in the next 10 to 15 years. Pennsylvania’s state budget is about $33 billion, and its deficit is $3 billion.

“That’s just one state,” Antonelli said. “If you start to add them up, it’s not an insignificant amount.”

What the programs look like

This is where the states come in. There are currently three types of models for state-sponsored retirement plans:

• Mandatory individual retirement accounts with auto-enrollment: Private-sector employers that don’t offer retirement accounts must give employees access to state-run IRAs, either established as a traditional IRA, to which employees allocate pretax money, or a Roth IRA, into which is placed employees’ after-tax dollars, which then grow tax-free and are withdrawn tax-free.

• Marketplace plans, which establish a platform through which any employee — including freelancers and the self-employed — can choose from a variety of low-cost retirement-account options offered by financial firms that contract with the state.

• Multiple-employer plans, which pool employee accounts from numerous companies. These are 401(k) plans, not IRAs, which allow workers to save more.

Those programs resemble myRA, the federal government’s program for private-sector workers to save for retirement, said Hopkins, of the American College of Financial Services. MyRA was shuttered in summer 2017 because it was considered a failure. The goal of myRA was, as is with state plans, to offer retirement accounts to Americans without access to a workplace program. There were only about 20,000 investors participating in the three years the plan existed, with a total of $34 million contributed. About 10,000 accounts were opened but had no money in them.

States learned a valuable lesson from myRA: Plans will only go so far as the features they offer, namely automatic enrollment.

“Auto-enrollment is a big piece, and that’s the only way it will work,” Hopkins said.

Criticism of state plans

Not everyone agrees that state-sponsored plans are the way to go.

“The issue isn’t that small employers don’t have alternatives available that are inexpensive and participant-friendly,” said Ted Benna, the creator of the 401(k) plan. “They probably just don’t know about it.”

Smaller employers often end up with 401(k)s when there are better alternatives — ones that, for a small business, would be less complex, less expensive and less riddled with liability risks. Benna has created other models for retirement plans similar to the traditional 401(k) plan. One, called Benna 401(k) Plan Model 3, is available to employers with 100 or fewer employees and allows for employer contributions.

Plus, technologically savvy companies such as Betterment and Dream Forward 401(k) are cropping up to streamline the process for small businesses, and are offering them as low-cost “solutions.”

Part of the problem might be that people are too hung up on the 401(k). Benna never expected his idea to become as popular as it is today. When he first devised the concept in 1980, he had to work hard to market it. Pensions had already begun their steep decline at that point, and companies were putting the onus on employees to fund their futures.

“Saving for retirement is a totally strange thing, so we had to sell it to employers and sell it to participants,” he said.

Now 401(k) plans are ubiquitous.

“We are talking about a vehicle that was never considered to be the primary retirement vehicle,” Benna said, adding that 401(k)s were designed as just one option for retirement savings. Benna is now working to promote other retirement-plan models that focus on replacing income in retirement instead of building a nest egg during working years.

Benna argued that the state-sponsored plans are more expensive than other alternatives, and employees incur the fees. OregonSaves costs participants about 1%. Betterment for Business, an online investment firm, offers employers 401(k) plans that might cost less, depending on the size of the company and how many employees would participate. (For a plan size of $2 million with 50 employees, the total estimated annual fee would be 0.61%, which either the employer or employee could pay.)

Another criticism is that governments aren’t as well-versed in retirement products as financial firms are. Allan Katz, president of Comprehensive Wealth Management Group in Staten Island, N.Y., said state-sponsored plans force employers and employees to use a particular vendor, which means plan sponsors and participants can’t make their own choices.

California’s legislation requires employers with at least five employees to participate in a retirement plan — but it doesn’t have to be CalSavers, Selenski said.

Market failure

“We would be thrilled if the results of this requirement had employers choose to offer a 401(k) or a more generous program,” Selenski said. “We would consider that a great success.”

Read, Oregon’s state treasurer, said state plans help private companies more than critics may think. “If there wasn’t a market failure, we wouldn’t need to do this,” he said. “We’re creating customers for them in the long run, as I think people will get, over time, dissatisfied with our very basic options and roll it into other things.”

OregonSaves, like other state programs, is meant for people without options, said Lisa Massena, vice president of business development at Dresher, Pa.-based Ascensus, the investment company that Oregon, California and Illinois hired for their programs. Employers have said they were interested in implementing a plan but never got around to it, and that they don’t like the state’s options so they’ll go elsewhere for their employees, she said.

“This is a rising tide that floats many boats,” Massena said.

And as for the states? They don’t seem to mind — at least not Oregon.

“For us, that’s a win, too,” Read said. “That’s the point.”

Alessandra Malito is a reporter covering personal finance and retirement for MarketWatch.